Increased Energy Prices Slowing Global Economy

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It seems like just another Monday. But the world always changes a little over the weekend. And this weekend, we reckon it changed a lot. The Opes story dominates the headlines. But the collapse of margin lending and leverage probably isn’t the biggest story this week. It’s the increase in food and energy prices we have our eye on this week.

But first, congratulations to Andrew Forrest! Ever since Lang Hancock and other pioneers opened up the Pilbara to the world in the 1950s, the region has been dominated by BHP Billiton (ASX: BHP) and Rio Tinto (ASX: RIO). Those two quarreling love birds have thus far owned all the rail and port infrastructure to export Australia’s red iron ore to China, Japan, and Korea.

The duopoly has become a triopoly as of this weekend. Fortescue Metals (ASX: FMG) completed the rail line between its Cloudbreak mine and its new port facilities on the coast. Fortescue still hasn’t actually shipped any iron ore yet. But the company can now get the iron ore from the mine to the sea. Its first shipment is scheduled for next month.

Don’t expect Fortescue to produce iron ore in the same volume as the big boys. But then, it doesn’t have to. The iron ore market has changed at the margin. Smaller steel makers in Asia are more than willing to enter into contract agreements with smaller ore producers in Australia.

This is a key feature (and opportunity) in the resource boom: the expansion of consumers has led to an expansion in producers. The marginal producers (some of them anyway) are now economically viable. The whole market is bigger, giving retail investors more to choose from in the share market.

Three billion people in the world eat rice as a staple of their daily diet. No wonder there are rice riots. Javier Blas of the Financial Times reports that, “Rice prices rose more than 10 per cent yesterday to a record high as African countries joined south-east Asian importers in the race to head off social unrest by securing supplies from the handful of exporters still selling the grain in the international market.”

Rice farmers are sitting on huge profits. It’s not complicated. There are more buyers than sellers. And the sellers are selling something pretty valuable: daily calories. This isn’t your garden variety shortage in video game consoles or iPhones.

“The rise in prices – 50 per cent in two weeks – threatens upheaval and has resulted in riots and soldiers overseeing supplies in some emerging countries… The increase also risks stoking further inflation in emerging countries, which have been suffering the impact of record oil prices and the rise in price of other agricultural commodities – including wheat, maize and vegetable oil – in the past year.”

“Bankruptcy filings jump 30%,” reports the Los Angeles times. “More than 90,000 bankruptcy filings were made in March, the highest since insolvency laws became more restrictive in October 2005,” the Times reports. “California led the nation with a 42% increase in bankruptcy filings at an annual pace in the first quarter, according to Jupiter ESources.”

California is always at the leading edge of American economic trends. This is not a good sign. The bankruptcy laws passed in 2005 were a big fat wet legislative kiss to the credit card companies. They make it very hard for Americans to declare bankruptcy. The fact that so many have anyway tells you how grim the situation is.

Meanwhile, the big wigs at the International Monetary Fund put out the bat signal over the weekend, arguing for more intervention in the credit markets. Why is that? Could it be that the U.S. Federal Reserve’s generous lending at the discount window to investment banks has failed to improve the quality of hundreds of billions if bad debt still sitting on investment bank and bank balance sheets?

“I really think that the need for public intervention is becoming more evident,” says International Monetary Fund managing director Dominique Strauss-Kahn. He says that a “third line of defence” is necessary to reinforce monetary and fiscal policy. Those lines are not holding.

Inflation batters them in the food and energy markets while deflation in financial prices continues its relentless assault. “Effort has to be made on loan restructuring. With respect to the banks, if capital buffers cannot be repaired quickly enough by the private sector, use of public money can be examined.”

Hmmn. Well, good luck with that. It is quite obvious that the post-war institutions designed to facilitate the expansion of global markets (the International Monetary Fund, the World Bank, the dollar standard itself) are under heavy stress (this makes sense when you realise the main tool of global expansion is credit… and we now have a bear market in credit). It is not at all obvious what will replace these institutions of expansion, or if anything can.

That’s a scary but perfectly reasonable thought. Think of the global economy as a system of systems. Food, energy, credit, transportation, information… all these systems are interconnected and interdependent. Energy is what keeps them all connected.

As the price of energy grows, the connections become stressed and frayed. A world with more expensive energy is a less connected world. When you stop throwing cheap energy at an economy, its total growth slows down and the real growth becomes more isolated and selective.

Reserve Bank board member Roger Corbett warned Australians about the problem least week. He said that energy prices may go up by a factor of ten. “The impact of that energy becoming scarcer and the marketplace costing the real cost into energy, is going to create certainly an upward pressure on the cost of energy.”

There is an embedded energy cost in everything you use (or eat) in the world. When goods start reflecting that increased cost of energy, they will get more expensive. “The only way to curb it and to fairly balance it is really the marketplace and the marketplace will cost energy much (higher). I don’t think it’s beyond the realms of possibility that it could go to five times the current level or even more. I think we’re looking at the five to 10-year timeframe.”

Is this good news for anyone? It’s certainly not goods news for consumers. The oil producers? Here’s a newsflash: the big, greedy, publicly traded oil companies don’t control most of the world’s oil reserves (making it hard for share market investors to profit from the increase in the underlying price.) National oil companies in Mexico, Venezuela, Russia, and the Middle East own the world’s oil reserves. You can’t buy a share in Vladimir Putin, Inc.

This is why we reckon the market for oil and gas alternatives is potentially lucrative. You can conserve your energy use. You can improve the efficiency of energy using appliances. But ultimately, the world is going to have to diversify its sources of energy, or face much leaner times ahead due to higher energy prices.

Yet lean times may be head even if we do get an explosion in energy innovation. For two hundred years food and energy prices have tended to go down. That’s a pretty powerful long-term trend. But the world’s population started the 20th century and about one and a half billion. It finished the century at six billion. Since 1961 alone the population has doubled.

Huge increases in the productivity of farmland (the Green Revolution) and the relative stability of a fiat money global dollar standard, plus a healthy supply of cheap energy, made this global expansion possible. Now, money and energy are both becoming more expensive. The shockwaves resulting from their increased cost are spreading. And one of the first sectors to get hit (as the rice story above demonstrates) is agriculture.

“The UN International Fund for Agriculture predicts food riots will become common on the world scene for at least a year. The World Bank says 33 countries face unrest from higher prices in both food and energy,” reports today’s Christian Science Monitor. “Egypt’s government said police arrested more than 500 people across the country as it suppressed a one-day national strike to protest rising food prices,” reports Bloomberg.

Last week, three small regional airlines in the United States went bankrupt and ceased operations. They all cited the rising cost of jet fuel as the main reason their economic model went belly up. An energy scarce world is a less mobile world, quite literally.

The Australian Petroleum Production and Exploration Association (APPEA) sees all this and says, “explore!” “Australia’s oil explorers need to widen their search for discoveries in so-called frontier areas to avoid a $28 billion petroleum trade deficit within a decade,” according to Angela Macdonald-Smith at Bloomberg.

“Australia has 50 sedimentary basins, of which just 12 are producing oil and gas, pointing to potential for drilling in little-explored areas,” says APPEA CEO Belinda Robinson. If Australia doesn’t find more domestic oil, it will be importing 80 of its refined petroleum products by 2015, according to Resources and Energy Minister Martin Ferguson.

And while we’re on the subject of how complex civilisations collapse, let us pay tribute to the late great Charlton Heston. You may remember him as Moses, or Judah Ben-Hur (the chariot race in the Coliseum is one of the great scenes in film). But our favourite Heston film is easily Planet of the Apes.

Is there a better ending scene in the movies? Note, if you haven’t seen the movie, don’t let us spoil it here. If you have, read on. Heston’s character, astronaut George Taylor, has escaped from his monkey captors on horseback with a gorgeous brunette.

It’s a little like Adam and Even on horseback going up the beach into the future. But Taylor finds out that this planet is not some bright new future, but an awful past. Round the corner of the coast they run into a half buried Statue of Liberty.

“You maniacs,” Taylor yells. “You blew it up. You finally did it. Damn you. Damn you all to hell,” he yells.

That was in 1968, when it seemed like the world would end in nuclear holocaust. It didn’t (thank goodness). But has anyone planned for a world that just kept growing? And is that lack of planning now showing up in higher food and energy prices? It sure looks like it. Now, we wonder what’s next…

Dan Denning
The Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.
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Comments

  1. Terrifying article. It’s been there waiting for us to pay attention, but I don’t think anyone thought that the global economy would be hit so hard so early in this century. If the minor energy and food hiccup this year is already causing enormous repercussions, just what does the next decade bring?

    beyondtool
    April 7, 2008
    Reply
  2. We need to cut spending on unnecessary endeavors (ending the occupation of Iraq would be a good start) and start massively subsidizing energy efficiency technologies and wind, solar, and geothermal energy while electrifying our transportation system. This will in the long run make us energy and food secure.

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  3. Yes, there is an immediate need for massive subsidies targeted towards alternative energy sources and energy efficient technoligies.

    But, we also need to reduce the growth rate of the population to assist in food shortages and resource consumption, untl we have a plan. All governemnts need to at least start restricting families to having 2 children.

    Dan’s last paragraph hits it.

    “But has anyone planned for a world that just kept growing? And is that lack of planning now showing up in higher food and energy prices? It sure looks like it. Now, we wonder what’s next…”

    Yes planning. This lack of planning by the governments and institutions that run our economies will bite us in the end. It’s a reflection of what we have always wanted, surely it is, otherwise why is it happenning?

    Evolution? Just how much have we learnt from our fellow humans throughout the course of time? Maybe we need to endure greater sufferring in order to bring new focus to the world? We had the opportunity and we still do, but not much is happenning, it all a little superficial.

    I am 27 years of age, the Baby Boomer generation and previous generations are just going to dump the problem on future generations , as long as they themselves lived a good life. No empathy for the struggle that future generations will have to endure.

    Maybe, we shouldn’t allow people to reproduce at all until we collectively become responsible enough to bring beautiful life into this beautiful universe?

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  4. It’s not about the world growing too much. It’s about psychopathic control freaks who own the media and totally control what 99% of the world’s population thinks. It’s a simple principle: garbage in = garbage out. It’s time to take a look at those who are supplying the garbage.

    We’ve known about peak oil for 50 years. It’s a basic scientific principle. Yet even today you’ve got 1000 times more discussion about the deadly CO2 gas. And how many times has this author mentioned peak oil? How many times has any “reputable” media source mentioned it over the last 5 years? Not many. That is no accident. It’s called eugenics.

    Reply

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